The cement industry in Pakistan has come a long way since independence
when the country had less than half a million tonnes per annum production capacity. By now
it has exceeded 10 million tonnes per annum as a result of establishment of new
manufacturing facilities and expansion by the existing units. Privatization and effective
price decontrol in 1991-92 heralded a new era in which the industry has reached a level
where surplus production after meeting local demand is expected in 1997.

The cement industry in Pakistan faces two serious threats: closure of
units based on wet process, and poor cash flow rendering the units incapable of debt
servicing due to increasing cost of electricity, furnace oil and imported craft paper used
for cement packing. The cost of furnace oil alone has increased by nearly 100% in the last
15 months alone. With the increase in furnace oil the increase in electricity tariff has
also become inevitable.

Pakistan has remained a net importer of cement but due to the
privatization of units operating under state control and subsequent expansion programmes
by the new owners supported by financial has pushed the industry to a point where the
country is bound to reach an oversupply situation. However, the recent increase in energy
cost provides opportunity for the efficient units based on dry process to sustain the
situation for a relatively longer period. It would also be possible because the expansion
by the existing units and establishment of new units are being delayed.

Pakistan's cement market is divided into two distinct regions, North
and South. The northern region comprises the Punjab, NWFP, Azad Kashmir and upper parts of
Balochistan, whereas the southern region comprises the entire province of Sindh and lower
parts of Balochistan. Traditionally, the southern region has always been surplus in cement
production but with the establishment of more plants in the northern parts of the country
the region has become almost self-sufficient in supply of cement.

Demand vs supply

The demand-supply gap which for the last decade was in favour of
manufacturers is now set to switch the other way with supply outpacing demand by the end
of 1997. Historically, demand has grown at an average rate of 7%, with the Northern region
averaging 8% and Southern region lagging behind at 4%. There is much pessimism about the
industry's future due to a tremendous increase in supply expected by the end of next year.

The way new plants are being established and existing plants are
undertaking expansion, the demand-supply equation is bound to create surpluses. However,
it has been observed that actual progress is slower than planned to avoid a possible glut
situation. This will effectively narrow down the gap between demand and supply and thereby
ease the pressure on prices.

Factors which can possibly change the surplus position into a
near-equilibrium between demand and supply are:-

Formation of manufacturers' cartel to avoid price decline;

Delay in implementation of planned additions and expansions;

Efforts to export cement; and

Increase in demand if construction of some of the mega-sized
infrastructure projects starts

More competition

As the cement market is moving from a virtual 'sellers' market' to an
over-supply situation, it is expected that when prices stagnate and profitability becomes
a function of volume and economies of scale, locational advantage and proximity to markets
will become extremely important factors.

At present the freight charges are a massive 20% of the retail prices.
The plants located very close to each other and tapping the same market will have to
expand their markets which will increase their freight expenses.

Dandot, Pioneer, Maple Leaf and Garibwal are all located within a
radius of 100 kilometres and are selling bulk of their production in the same areas and
will thus face serious competition from each other.

Positive side

Pakistan has one of the highest population growth rates in the world,
touching 3%. This has prompted a sizable demand for housing facilities in the country.
According to estimates of construction industry, there is a huge backlog of about 6.25
million housing units in the country. Bulk of the current demand of 0.6 million units
needed every year is for urban areas. With greater urbanisation the demand for cement is
expected to grow at an average of nearly 7% per annum.

The demand for cement for infrastructure units is expected to grow with
the commencement of work on motorways, power plants, Islamabad New City, Karachi Package
and Ghazi Brotha dam. If all these projects are implemented as per schedule, the demand
for cement is expected to grow at a higher rate.

Tax structure

Instead of providing any relief in the budget, the sector was further
penalized with a 3% increase in sales tax to 18% and an increase in excise duty to 35%. So
far, the manufacturers have been able to pass on the increase to consumers but the
situation is unlikely to continue. However, the possibility of formation of a cartel
cannot be ruled out. Since massive investment has been made in the sector, any reduction
in price of cement can reduce profit margins of all the units.

Formation of cartel and fixation of price at a level high enough to
cover increasing costs of inputs and ensure reasonable profit margins may provide a
short-term relief to the manufacturers. Such a cartel may be against the interests of
consumers but can help the manufacturers to survive with some dignity.

Formation and smooth operation of a cartel is generally difficult but
in the case of cement industry it may not be so because the only restriction could be on
the level of capacity utilization along with a modest uniform reduction in price of
cement. However, the units are in diverse states of financial health, enjoy different
levels of competitive advantage, and therefore need different prescriptions to maintain
their profitability.

Production process

Each tonne of cement requires about 1.7 tonne of limestone, gypsum and
silica, etc. By volume limestone accounts for about 80% and clay 19% of the intermediate
product  clinker. Gypsum is later on added to clinker in the ratio of 4:96 to obtain
cement. Pakistan has all these raw materials in abundance and the country can feed these
material to existing cement plants for more than 100 years. This ensures both cheap and
smooth supply of raw materials but proximity to raw materials supply is not a major
competitive advantage.

Production of cement is a continuous process. Raw materials are dried,
ground, proportioned and homogenised before being burnt in rotary kilns. The resulting
material 'clinker' is pulverised with gypsum at the grinding stage to obtain cement.

The cement industry in Pakistan uses two distinct production processes,
the 'dry' and the 'wet' process. Both the processes use different types of kilns. In the
wet process raw materials are fed into kiln in slushy form. As it consumes more energy to
raise the temperature of the kiln to the required levels it is costly. In the dry process
the ground raw materials are fed into the kiln in dry powder form therefore energy
consumption is low to raise the temperature to the required level.

Cement plants established in Pakistan upto the seventies were based on
wet process whereas the plants established in the eighties and onward are based on dry
process. These include the plants established by the SCCP and the private sector. As of
June 1995, 60% of the production capacity was based on dry process which has further
increased as the newer units are also based on dry process.

Cost of production

Since the industry faces a situation where sales price will be fixed by
mutual consensus, the cost of production will be the most critical factor of
profitability. Energy cost is a major component of total cost of production. It
contributes at an average 40 to 45 percent towards total cost of cement production. Energy
cost is even higher in case of those plant which use wet process. A cement plant based on
wet process consumes 165 kg of furnace oil to produce one tonne of clinker as compared to
85 kg of furnace oil used in dry process to produce the same quantity of clinker. Since
cement plants use both furnace oil and electricity, any increase in the prices of these
two products is detrimental to profitability of the industry. Ever since October 1995,
however, there has been more than 60% increase in the price of furnace oil.

Another significant cost component is packaging material. Cement is
rarely sold in bulk in Pakistan  almost all cement sales are in four-ply papersacks.
Cost of papersacks has gone up by almost 90% since December 1994. Only one unit, Cherat
Cement, has the advantage of having an associate company producing such bags.

Key players

Until recently there were 24 cement manufacturing units in the country
which were reduced to 23 with the closure of National Cement's Karachi unit. Out of these,
2 units produce white cement, one slag cement and the remaining produce ordinary Portland
cement (OPC).

Cherat Cement located in NWFP has an installed capacity of 0.72 million
tonnes per annum. Cherat was the first cement plant in the private sector to commence
commercial operations (1985) after the end of state monopoly. Its main markets are NWFP
and upper Punjab. The company is owned by Ghulam Faruque group which also owns Cherat
Papersacks.

The company has recently doubled its capacity and expansion has come at
an appropriate time. It is in a position of taking advantage of the 'cement hungry
northern region' for capacity utilization. Expansion also provides potential of achieving
economies of scale. Given Chreat's established marketing base it could be the immediate
beneficiary if export of cement to Afghanistan is allowed  the country needing
massive reconstruction after devastation of a long war.

However, commencement of commercial production by Lucky and Army
Welfare plants may create over-supply even in the Northen region. Cherat will have to
spend more on transportation cost as it will have to tap distant markets to sell
production from expanded capacity. Constant increase in fuel prices will add to total
transportation expenses of the company in a substantial way  currently the freight
cost comes to more than 20% of retail prices of cement.

D.G. Khan Cement was the most prized unit out of the cement units
privatised by the Nawaz Sharif government. Of all the plants owned by the SCCP it was the
most modern plant with bulk of depreciation amortised and interest charges paid for. The
company enjoys a virtual monopoly in its sales territory. There is no other cement plant
within a radius of 400 kilometres. The current capacity of 720,000 tonnes per annum (TPA)
is being enhanced to 1.809 million tonnes at a cost of Rs. 6 billion. The IFC is also
participating in the project with a loan component of US$ 65 million and equity worth US$
5 million.

The expansion will come on line at a time when there will be supply
overhang in the industry. With margins coming under pressure it will have to bear the
added brunt of higher financial charges and increased depreciation cost in the years to
come.

Analysis of the latest half-yearly results of the company shows that
although sales of the company have gone up by 3.5%, the increase in cost of sales has
reduced gross margin from 61% to 48%. With rising inputs cost not being matched by similar
increase in price of cement, margins are expected to shrink further. The company, after
the expansion is expected to face fiercer competition from Zeal Pak, Pioneer, Dandot and
Wah. To wrest market share from the competitors, it is likely that D.G. Khan will have to
reduce its cement prices.

Dandot Cement, privatised in 1992, was able to wipe off its accumulated
losses by the end of its first financial year after privatisation. Dandot has increased
the plant capacity from 1000 tonnes to 1600 tonnes per day, through an optimization
programme completed in July1995.

The Chakwal Group, which acquired management control of Dandot Cement,
is setting up another cement plant, Chakwal Cement  the largest cement plant in the
country. This will give the Group control over 2.3 tonnes per annum production. The
decision to set up another plant in the same vicinity could go both ways. On the positive
side it could provide leverage to out-price competitors especially as the industry moves
towards a possible over-supply situation. Chakwal Cement is located close by a motorway to
be constructed which provides it an opportunity to market its cement in large quantities
to the project.

On the negative side, Dandot is a highly unionized concern and suffers
from a strained labour-management relationship which has led to plant closure in the past.
In addition, the investors are losing confidence in the Group mainly due to delayed
commencement of its much-talked about Dhan Fibres project.

Cement export

The federal government's decision to allow export of clinker and cement
by the private sector has been eclipsed due to absence of necessary rules and regulations.
The export consignment of clinker by a unit was delayed as the customs authorities refused
to allow export. The federal government on August 13 issued a notification which stated
"Export of cement and clinker will be allowed by sea on such terms and conditions as
may be notified by the ministry of commerce.

Since consumption of cement in southern region has gone down and
northern region has attained self-sufficiency, units located in southern region are forced
to cut down their capacity utilization. The possibility of cement export is the proverbial
silver lining for the recession-torn industry according to analysts at AKD Securities
While there are cement deficient countries like Bangladesh and Sri Lanka importing
approximately 2 million tonnes per annum each, there is tough competition from India and
Chinese suppliers.

In fact, apart from the prices offered by Pakistani manufacturers, lack
of facilities for handling bulk export of cement has become a major impediment  bulk
handling is cheaper than handling bagged cement.

Export of cement is necessary for the existence and survival of the
industry rather than a source of profit. The announcement of policy on cement export has
created positive sentiments.

Future outlook

At the current point cement manufacturers and the government have to
take concrete steps even to keep units in production. On the inputs side, necessary steps
are required to contain the increasing energy cost. The government must also look into the
case of providing subsidy on freight to the exporters of clinker and cement. The
prescription is to optimize capacity utilization.

According to analysts the future of cement exports depends on two
factors: surge in cement prices in the export markets and the government of Pakistan
subsidising freight charges. While the quantity of exportable cement in the region would
gradually decline and prices are expected to increase, it will take time to get a
favourable decision from the government to provide subsidy even on freight cost. But
absence of bulk cement handling facilities will remain a major deterrent.

Lucky cement which completed its construction at a fantastic speed to
qualify for duty exemptions has met the fate apprehended by the industry experts. Due to
various technical problems including sinking of some foundations, the management was
forced to close down the production soon after starting commercial production. It is
feared that it would not be able to resume production till the first quarter of the next
calendar year.

But prospects of recovery of cement industry have been further reduced
due to another recent increase POL prices. Electricity tariff is also expected to be
revised upward shortly. The advantage of devaluation has been eroded almost completely due
to increase in energy cost.

Historical perspective

The history of cement industry in Pakistan dates back to 1921 when the
first plant was established at Wah. At the time of independence in 1947 there were four
cement factories with an installed capacity of 470,000 tonnes per annum. These units were
located at Karachi, Rohri, Dandot and Wah. In 1956 Pakistan Industrial Development
Corporation (PIDC) established two plants at Daudkel and Hyderabad and subsequently more
plants were established in the private sector.

The industry was nationalised in 1972 and the State Cement Corporation
of Pakistan (SCCP) was established following the Economic Reforms Order, 1972. As a result
of nationalisation, a total of 10 cement units with an installed capacity of 2.8 million
tonnes per annum were transferred to the SCCP. Effective price control was also vested
with the SCCP and for a long time the industry operated under a regime of strict
regulation and price control. While the cement industry was working under state control,
the SCCP established five new units with an installed capacity of 1.8 million tonnes per
annum.

In 1985-86 the cement industry was deregulated and private sector was
allowed to establish cement plants. But bulk of the capacity was controlled by the SCCP
which had effective control in the fixation of prices. Severe shortage of cement and price
deregulation prompted the private sector to establish more plants. Seven units were
established in the private sector before commencement of the process of privatisation in
1991.

During the regime of Nawaz Sharif the industry went through major
transformation. The government embarked upon an ambitious privatisation programme and
eight units have been privatised so far. The SCCP at present controls less than 25% of the
total installed capacity in the country which is shrinking with the establishment of more
plants in the private sector and expansion in the privatised units. The units working
under the SCCP control are old and inefficient using 'wet process' whereas the units
established in the private sector are new, efficient and use 'dry process'.

Cement manufacturing is a high capital- and energy-intensive industry.
The capital cost of a 2000 tonnes per day (TPD) plant ranges between Rs. 3.5 billion to
Rs. 4 billion whereas the capital cost of a 3000 TPD plant is estimated at more than Rs.
5.5 billion. Energy consumption by cement manufacturing units based on 'wet process' is
higher than 'dry process'. The 'dry process' is estimated to be economical by 40% to 50%
compared to 'wet process'.

Installed capacity

Cement Plants in Northern Region (000 tonnes) per annum

1) Associated (Wah) 900

2) D.G. Khan 1,710

3) Cherat 720

4) Pioneer 660

5) Mustehkam 660

6) Fecto 600

7) Kohat 330

8) Gharibwal 540

9) Maple Leaf 1,460

10) Dundot 480

11) Lucky Cement 1,200

Sub-Total 7,580

Cement Plants in Southern Region

12) Zeal Pak 880

13) Attock 660

14) Javedan 500

15) Pakland 540

16) Dadabhoy 450

17) Thatta 280

18) Associated (Rohri) 230

19) Essa 150

Sub Total 3,690

Cement Plants Under Construction

20) Saadi 960

21) Lucky 1200

22) Army welfare 660

23) Fauji 900

24) Chakwal 1,650

Sub-Total 5,370

Grand Total 16,640

Lucky Cement

Lucky Cement is a 1.2 million TPA greenfield project based on dry
process. Plant and machinery has been supplied by China  the biggest Chinese plant
outside China. It is located near Pezu village in NWFP and enjoys sales tax exemption
until year 2001  a unique competitive edge apart from having the lowest project cost
among upcoming cement plants. Lucky Cement also holds 100% equity of Lucky Powertech which
would supply power to the cement plant upon completion.

While Lucky's advantages include sales tax exemption, nominal financial
charges  it is almost totally equity-based  the possible risks are: location
in a remote area which would result in higher transportation cost of cement, spread over a
huge equity-based EPS would always be low and reservations about Chinese technology.

Lucky completed its construction at a frantic speed to qualify for duty
exemptions but the apprehensions expressed about the structure came true. The unit was
closed down soon after commencement of commercial production due to technical reasons
including sinking of some strategic foundations. It is feared that it would not be able to
resume production for another three months.